Investment company that issues a class of conventional shares and a class of exchange-traded shares in the same fund

ABSTRACT

An automated method is provided for administering a single investment company that issues one or more classes of shares that are bought from and redeemed with the single investment company at a net asset value and issues one or more classes of shares that are listed for trading on a securities exchange and that are bought and sold at negotiated market prices. One or more computers maintain account data of the outstanding shares. An owner of any share of any share class has an undivided interest in the single investment company.

CROSS-REFERENCE TO RELATED APPLICATIONS

This application is a continuation of copending U.S. application Ser.No. 12/781,203 filed May 17, 2010, which is a continuation of U.S.application Ser. No. 12/036,626 filed Feb. 25, 2008, now U.S. Pat. No.7,720,749, which is a continuation of U.S. application Ser. No.11/093,183 filed Mar. 28, 2005, now U.S. Pat. No. 7,337,138, which is acontinuation of U.S. application Ser. No. 09/801,128 filed Mar. 7, 2001,now U.S. Pat. No. 6,879,964. The entire disclosures of each of theseprior applications are incorporated herein by reference.

COPYRIGHT NOTICE AND AUTHORIZATION

Portions of the documentation in this patent document contain materialthat is subject to copyright protection. The copyright owner has noobjection to the facsimile reproduction by anyone of the patent documentor the patent disclosure as it appears in the Patent and TrademarkOffice file or records, but otherwise reserves all copyright rightswhatsoever.

BACKGROUND OF THE INVENTION

Investment companies are corporations or trusts that are in the businessof buying and selling securities. Such companies issue shares that arebought by investors. The value of an investment company's shares ismeasured by adding up the value of the securities it owns (and any otherassets), subtracting liabilities, and dividing by the number ofoutstanding shares. This figure is known as the investment company's“net asset value” (NAV). It is typically calculated once per day, at theclose of the financial markets.

There are three main types of investment companies: open-end funds,closed-end funds, and unit investment trusts (UITs). The shares issuedby open-end funds and UITs are redeemable, i.e., they can be tenderedback to the issuer in exchange for cash (or in rare cases securities) inan amount equal to the NAV of the shares tendered. Closed-end fundshares are not redeemable. To provide liquidity to an investment in aclosed-end fund, the fund sponsor typically lists the shares for tradingon a stock exchange. After the initial issuance of shares by aclosed-end fund, the fund's shares are bought and sold over the exchangeat market prices determined by supply and demand.

Investors who want to sell shares of a closed-end fund can do so at anytime that the stock exchange is open at the then-current market price.The market price of a closed-end fund's shares differ from, and areoften well below, the NAV of those shares. Shares of open-end funds andUIT's, by contrast, can be redeemed only at the NAV determined at theend of the day.

A hybrid investment company, commonly known as an “exchange-traded fund”(ETF), has recently arisen that seeks to provide investors with the bestaspects of closed-end funds (intra-day liquidity) on the one hand andopen-end funds and UITs (redeeming one's shares at or above NAV) on theother. ETF's are open-end funds or UIT's whose shares are listed fortrading on a stock exchange. (The shares issued by ETFs are referred toherein as “ETSs,” for “exchange-traded shares.”) Unlike the conventionalshares issued by open-end funds or UIT's, ETSs have certaincharacteristics that more closely resemble common stock or the shares ofclosed-end funds:

(1) ETSs are listed for trading on a stock exchange;

(2) ETSs may be bought and sold at any time during the exchange'strading hours at prevailing market prices; and

(2) The market price of ETSs fluctuates throughout the day based onsupply and demand.

Although there is no requirement that they do so, ETSs issued to datetrack stock indices, such as the S&P 500 Index or the Nasdaq 100 Index.ETSs are particularly popular with short-term investors and traders,market timers, and speculators.

The current approach taken by an investment company sponsor that wantsto offer ETSs is to create a new investment company for that purpose.The new investment company issues the ETSs. Shareholders are allowed tobuy or sell the ETSs which are held in brokerage accounts.

Investment company sponsors that do not currently provide ETSs facecompetitive pressures to offer ETSs to their shareholders so as toretain the assets of the existing shareholders who prefer ETSs toconventional fund shares, and to attract the assets of new shareholderswho may wish to trade ETSs as part of their portfolio. However, thereare significant disadvantages to the current approach of creating a newinvestment company to offer ETSs to customers:

(1) Creation of a new investment company creates additional overheadcosts for the sponsor.

(2) In the case of an index fund, a new investment company may notimmediately attract a sufficient quantity of assets to accurately trackits target index.

(3) Lack of cash purchases into an investment company, no matter whatits size, impedes the ability of the company to track its target indexand adjust the portfolio of securities.

Accordingly, there is an unmet need for a scheme that would allowinvestment company sponsors to offer ETSs without having to create newinvestment companies for this purpose. The present invention fulfillssuch a need.

BRIEF DESCRIPTION OF THE DRAWING

The foregoing summary as well as the following detailed description ofpreferred embodiments of the invention, will be better understood whenread in conjunction with the appended drawing. For the purpose ofillustrating the invention, there is shown in the drawing an embodimentthat is presently preferred. It should be understood, however, that theinvention is not limited to the precise arrangements andinstrumentalities shown. In the drawing:

FIG. 1 shows a schematic block diagram of one preferred embodiment ofthe present invention.

BRIEF SUMMARY OF THE INVENTION

An investment company issues one or more classes of conventional sharesthat are bought from and redeemed with the company (either directly orthrough an intermediary) at NAV, and one or more classes of shares thatare listed for trading on a national securities exchange and that arebought and sold at negotiated market prices. Account data foroutstanding shares of all classes of shares are maintained in one ormore computers. The investment company may be an open-end fund, aclosed-end fund, or a UIT. The investment company could have aninvestment objective of tracking a specific target index of securitiesor the investment company could be actively managed by an investmentadvisor.

A shareholder can acquire ETSs of the investment company in one of threeways:

(1) by purchasing the ETSs in the secondary market through a broker, atthe prevailing market price;

(2) by converting a designated number of conventional shares into ETSsissued by the same company with an equal NAV; or

(3) if the purchaser is pre-approved as an “authorized participant,” byacquiring a predetermined number of ETSs directly from the issuing fundin exchange for a specified or individually negotiated basket ofsecurities (or securities and cash) with an equal NAV.

DETAILED DESCRIPTION OF THE INVENTION

Certain terminology is used herein for convenience only and is not to betaken as a limitation on the present invention. In the drawings, thesame reference letters are employed for designating the same elementsthroughout the several figures.

The present invention provides a computer-implemented process ofadministering an investment company. The investment company offersmultiple share classes, including at least one class of conventionalshares and at least one class of ETSs. Thus, in contrast to the currentapproach of offering ETSs by creating a new investment company thatoffers only ETSs, the present invention permits a sponsor to offer ETSsas a separate share class of a multi-class fund. The present inventioncould be used by existing investment companies that offer onlyconventional shares to provide ETSs to investors. Alternatively, thepresent invention could be used by newly established investmentcompanies to provide both conventional shares and ETSs to investors.

The investment company could be an open-end fund (e.g., open-end mutualfund), a closed-end fund (e.g., closed-end mutual fund), or a UIT. TheETSs issued by the investment company are publicly listed and traded ona national stock exchange, such as the American Stock Exchange (AMEX).The investment company could have an investment objective of tracking aspecific target index of securities (i.e., an index fund).Alternatively, the investment company could be actively managed by aninvestment advisor in a manner that does not attempt to track a targetindex.

Creating a new ETS class of an investment company that also offersconventional shares provides the following benefits:

(1) The investment company sponsor will incur less overhead costs sinceit is cheaper to create an additional share class of an existing fundthan to create a new fund.

(2) An investment company that offers more classes may attract moreassets. All other things being equal, an investment company with moreassets generally can track its target index more accurately.

(3) Redemptions from the exchange-traded class will be fulfilled in kindby selecting the lowest cost lots of each stock distributed. Thisprocess reduces the unrealized capital gains that currently exist in anexisting fund, thereby benefiting existing shareholders.

(4) The intra-day trading feature of the ETS class will draw markettimers out of the conventional shares, where they cause problems, intothe ETSs, where they do not. Market timers cause problems because theirfrequent purchase and redemption requests cause a fund to buy and sellportfolio securities more often, which increases transaction costs(e.g., brokerage commissions) and administrative costs (e.g., processingthe timer's trades, sending out confirmations). Additional costs lowerthe fund's performance and make it harder for the fund to track itstarget index. In addition, frequent portfolio transactions can increasethe fund's realization of capital gains. The uncertainty of frequentcash flows makes it more difficult to keep the portfolio appropriatelybalanced. These problems do not occur when the market timers hold ETSsbecause a timer's frequent trading of ETSs is effected on the secondarymarket with other investors, and does not affect the fund's portfolio.

(5) The conversion feature allows market timers and other investors tomove from the conventional share class to the ETS class withoutdisrupting the fund's portfolio. If market timers had to redeemconventional shares of a fund to move to an ETS class of the same fundor to an exchange-traded fund with the same investment objective, thefund would have to sell portfolio securities, causing the problemsdescribed above. The conversion feature eliminates those problems. Itpermits market timers and other investors to move from one class ofshares to another without incurring capital gains because, underInternal Revenue Service rules, exchanges between classes of the samefund are not taxable transactions.

In one preferred embodiment of the present invention, ETSs may beacquired in one of three different ways:

(1) If a shareholder owns conventional shares in the multi-classinvestment company, the shareholder may acquire ETSs by requestingconversion of a designated number or dollar value of conventional sharesto a monetarily equivalent number of ETSs. The shareholder's accountdata is then updated to reflect the new number of conventional sharesand ETSs.

(2) An investor may purchase ETSs directly from the investment companyin exchange for a basket of securities of generally equivalent monetaryvalue. Preferably, the direct purchase requires a purchase of apredetermined number of ETSs, known as a “Creation Unit.” The accountdata is then updated to include the newly purchased shares. A “CreationUnit” will preferably cost millions of dollars, and thus, Creation Unitswill be purchased primarily by institutional investors who have beenpre-approved.

(3) An investor may purchase ETSs on the secondary market through abroker. The account data of the investor is then updated to reflect thenew number of shares held by the investor.

In one preferred embodiment of the present invention, ETSs may be soldor redeemed in one of two different ways:

(1) An investor may redeem ETSs directly with the mutual fund inexchange for a basket of securities of generally equivalent monetaryvalue. Preferably, only Creation Units may be redeemed in this manner.

(2) A shareholder may sell ETSs directly on the secondary market througha broker.

In one preferred embodiment of the present invention, a conversion fromETSs to conventional shares will not be permitted.

The investment company of the present invention is less likely to sufferfrom the disruptive effects of short-term investors. As discussed above,short-term investors raise expenses by forcing an investment company toincur brokerage expenses and other transaction costs as portfoliosecurities are bought and sold to meet frequent purchase and redemptionrequests. They also increase the chance that the investment companymight have to sell stock to raise cash to pay a redeeming shareholder,causing the fund to incur capital gains and decreasing the taxefficiency of the fund. They also make it more difficult to ensure thatthe portfolio is appropriately invested with the desired amount of cashon hand. The present invention may also make it possible for aninvestment company to track its target index more closely by reducingtransaction costs, reducing the need for the fund to hold cash reservesto meet redemption requests, and spreading fixed costs over a largerasset base, thereby helping the investment company realize furthereconomies of scale.

In addition to the benefits listed above, the present invention willhave the added benefit of making available, in response to marketdemand, a security that provides a low-cost market basket product forinvestors that offers intra-day liquidity. Short-term investors areexpected to prefer ETSs to conventional shares when selecting the classof shares that the investor wishes to hold in the investment company.

One example of a commercial implementation of the present invention isprovided in Appendices A and B. In the example, selected funds of TheVanguard Group offer a conventional class of shares, and a class of ETSsreferred to as the VIPER Share Class. VIPER is an acronym for VanguardIndex Participation Equity Receipts. VIPER shares are thus a class ofexchange-traded securities that represent an interest in a portfolio ofstocks held by a particular Vanguard index mutual fund.

Appendix A includes selected portions of a prospectus of a RegistrationStatement for VIPER shares. Appendix B includes selected portions of aStatement of Additional Information (SAI) of a Registration Statementfor VIPER shares.

FIG. 1 shows a schematic block diagram of a system 10 in one preferredembodiment of the present invention. The system 10 coincides with thedescription of the investment company set forth in the RegistrationStatement.

The system 10 includes an investment company 12, investors A, B and C(labeled as 14, 16 and 18, respectively), a market maker or specialist19, brokers 20 and a clearinghouse 22. The investment company 12includes a first processor 24 that records one or more classes ofconventional shares issued by the investment company 12, and a secondprocessor 26 that records one or more classes of ETSs issued by theinvestment company 12. In the presently described embodiment, the firstprocessor 24 records one class of conventional shares issued by theinvestment company 12, such as a class of conventional shares that has arelatively small minimum investment of $1,000 or $3,000 (“investorshares”). Alternatively, the class of conventional shares could have arelatively large minimum investment, such as $10 million (“institutionalshares”). In the presently described embodiment, the second processor 26records one class of ETSs issued by the investment company 12. However,the scope of the present invention includes embodiments wherein pluralclasses of ETSs are issued. The investment company 12 also includes acomputer 28 for maintaining shareholder account data. For eachshareholder of the investment company 12, the computer 28 maintains arecord of the amount of conventional shares.

Investor A represents one or more investors who have purchasedconventional investor shares in exchange for cash. Investor B representsone or more investors who have purchased conventional institutionalshares.

Investors who wish to purchase VIPER shares in quantities smaller than aCreation Unit must purchase the shares on the secondary market through abroker. This process is represented by the investors C (labeled as 18),the brokers 20, the market maker or specialist 19, and the clearinghouse22.

A market maker is a financial entity that maintains firm bid and offerprices in a given security by standing ready to buy or sell round lotsat publicly quoted prices. On an exchange, a specialist is the memberfirm that makes a market in the stock and maintains the limit orderbook. In the present invention, the market maker or specialist 19(hereafter, “the market maker 19”) purchases VIPER shares in CreationUnits from the investment company 12 which are settled through theclearinghouse. The market maker 19 has a computer 37 for tracking itsaccount data. In the current financial industry, the clearinghouse 22 isthe Depository Trust Company (DTC). The DTC is a national clearinghousefor the settlement of trades in corporate and municipal securities andperforms securities custody-related services for its participating banksand broker-dealers. DTC is owned by members of the financial industryand by their representatives who are its users. The use of otherclearinghouses is within the scope of the present invention.

If an investor C wants to purchase VIPER shares, the investor C placesan order with its broker 20. The broker 20 then purchases the VIPERshares from the market maker 19 for the investor C. In this example, thebrokers 20 are labeled as broker 34 (broker 1) and broker 36 (broker n).Each broker 34, 36 has a computer for tracking brokerage account datafor its shareholders, labeled as elements 38 and 40, respectively. Eachbroker 34, 36 may have many investors. In this example, investor 42(investor C1 ₁) and investor 44 (investor C1 _(n)) have accounts withbroker 34, and investor 46 (investor Cn₁) and investor 48 (investorCn_(n)) have accounts with broker 36.

The clearinghouse 22 also tracks and records all VIPER shares that areissued as a result of a conversion of conventional shares to VIPERshares. Thus, the clearinghouse 22 has a record of all outstanding VIPERshares issued by the investment company 12. In one preferred embodimentof the present invention, a broker 20 executes the conversion throughthe same process described above for investors C. That is, theshareholder places the conversion request directly with a broker.

FIG. 1 shows only purchase transactions. Sell-type transactions areperformed by a reverse of the purchase transactions with the exceptionnoted above that a shareholder cannot convert a VIPER share into aconventional share.

The present invention may be implemented with any combination ofhardware and software. If implemented as a computer-implementedapparatus, the present invention is implemented using means forperforming all of the steps and functions described above. The presentinvention can be included in an article of manufacture (e.g., one ormore computer program products) having, for instance, computer useablemedia. The media has embodied therein, for instance, computer readableprogram code means for providing and facilitating the mechanisms of thepresent invention. The article of manufacture can be included as part ofa computer system or sold separately.

It will be appreciated by those skilled in the art that changes could bemade to the embodiments described above without departing from the broadinventive concept thereof. It is understood, therefore, that thisinvention is not limited to the particular embodiments disclosed, but itis intended to cover modifications within the spirit and scope of thepresent invention.

1. (canceled)
 2. A computer-implemented method of administering a singleinvestment company, the method comprising: (a) the single investmentcompany issuing, using a first processor, one or more classes of sharesthat are bought from and redeemed with the single investment company ata net asset value; (b) the single investment company issuing, using asecond processor, one or more classes of shares that are listed fortrading on a securities exchange and that are bought and sold atnegotiated market prices; and (c) maintaining in one or more computers,account data of the outstanding net asset value shares, wherein an ownerof any share of any share class has an undivided interest in the singleinvestment company.
 3. The method of claim 2 further comprising: (d) aninvestor purchasing or selling net asset value shares from the singleinvestment company; and (e) updating account data of the investor in theone or more computers to reflect the new number of shares of the held bythe investor.
 4. The method of claim 3 further comprising: (f) aninvestor purchasing or selling the exchange-traded shares on thesecondary market through a broker; and (g) the broker purchasing orselling the exchange-traded shares from or to a market maker on behalfof the investor to fulfill the investor's purchase or sell order.
 5. Themethod of claim 2 wherein there are a plurality of net asset valueshares shareholders and the account data includes an account for eachshareholder.
 6. The method of claim 2 further comprising: (d) ashareholder acquiring exchange-traded shares by requesting conversion ofa designated number or dollar value of shares belonging to the one ormore classes of shares that are bought from and redeemed with the singleinvestment company at a net asset value for a monetarily equivalentnumber of shares of the one or more classes of shares that areexchange-traded shares of the single investment company; and (e)updating the account data in the one or more computers to reflect thenew number of net asset value shares.
 7. The method of claim 2 furthercomprising: (d) an authorized participant purchasing the exchange-tradedshares directly from the single investment company in exchange for abasket of securities of generally equivalent monetary value, wherein adirect purchase requires a purchase of a predetermined number ofexchange-traded shares; and (e) updating the account data in the one ormore computers to include the newly purchased shares.
 8. The method ofclaim 2 wherein the single investment company is an open-end fund. 9.The method of claim 2 wherein the single investment company is aclosed-end fund.
 10. The method of claim 2 wherein the single investmentcompany is a unit investment trust.
 11. The method of claim 2 whereinthe exchange-traded shares are publicly listed and traded.
 12. Themethod of claim 2 wherein the single investment company has aninvestment objective of tracking a specific benchmark index ofsecurities.
 13. The method of claim 2 wherein the single investmentcompany is actively managed by an investment advisor.